Rising interest rates and market volatility

Are interest rates out of control?

The rise in long-term interest rates observed since the beginning of the year accelerated in September. Bond yields with long maturities rose significantly in the United States, Canada, France, the United Kingdom, Germany, Japan and even Switzerland. Bond markets, particularly long-duration assets, are under pressure, while the implied interest-rate volatility index (MOVE) has risen above 100%, a level not seen since March. To date, the increase in interest-rate volatility has had a limited contagion effect on other asset classes, such as equities, as implied equity-market volatility (VIX) remains close to its lows. However, as has repeatedly been observed in recent years, there is a point at which the level and pace of rising interest rates can unsettle equity investors.

Several factors may explain this significant increase in rates. The most frequently cited is the United States’ fiscal position and debt burden. The country’s USD 40 trillion debt and 5.8% fiscal deficit are raising concerns ahead of the 2027 federal budget, which has yet to be approved and is unlikely to reduce the deficit materially. Politically, this may be the Republicans’ last opportunity to pass a budget before losing their majority in Congress. Overall, investors appear to believe that they are not being sufficiently compensated for assuming this credit risk over the long term.

The rise in yields is also supported by resilient economic activity. Recent GDP and manufacturing PMI data highlight the strength of the US economy despite the energy and supply-chain shocks triggered by the war in Iran. With nominal economic growth of 6.3%, a 5.2% yield on 10-year US Treasury bonds does not appear excessive and may even have further room to rise.

Higher energy prices have also contributed to rising inflation expectations and are frequently cited as another cause of higher interest rates. However, long-term inflation expectations remain relatively well anchored at around 2.5%, as investors continue to believe in central banks’ ability to combat inflation decisively. This should limit the risk of a disorderly rise in interest rates and may provide an upper bound.

Finally, sovereign bonds are facing competition from creditworthy corporate issuers offering higher yields, such as hyperscalers. Corporate bond issuance has been substantial in 2026, and strong demand has allowed the market to absorb this supply, potentially at the expense of US Treasury demand. In addition, foreign central banks continue to diversify their reserve assets, replacing US Treasury bonds with assets such as gold. This trend has accelerated since February, when the war in Iran began. Conversely, some jurisdictions where many hedge funds are domiciled, including the Cayman Islands, Bermuda or the United Kingdom, have recently increased their holdings of US Treasury bonds. Replacing “strong hands” with fast-money investors is likely to generate additional volatility.

Unfortunately, the Federal Reserve has limited influence over long-term interest rates. For instance, the only way to reduce long-term US bond yields would be to curb economic growth through a significant increase in its policy rate. Given the current US economic and political environment, we believe that entering a new tightening cycle is however unlikely. Nevertheless, we do not believe that long-term interest rates are likely to rise rapidly to excessively high levels. Momentum and volatility could push yields higher by year-end, but we expect the adjustment to remain orderly. It is worth noting that, at some point, higher yields should naturally attract bond investors once they consider the compensation sufficient for the risks involved. The time for investors to reconsider long-duration bonds is approaching; however, in our view, it is still too early.